Passive Income Streams - The Master Key to Wealth Creation and Financial Freedom?

One of the keys to getting rich and creating wealth is to
understand the different ways in which income can be generated. It's often said that the lower and middle-class
work for money whilst the rich have money work for them. The key to wealth creation lies within this simple
statement.

Imagine, rather than you working for money that you instead made every dollar work for you 40hrs a week.
Better still, imagine each and every dollar working for you 24/7 i.e. 168hrs/week. Figuring out the best ways
you can make money work for you is an important step on the road to wealth creation.

In the US, the Internal Revenue Service (IRS) government agency responsible for tax collection and
enforcement, categorizes income into three broad types: active (earned) income, passive income, and portfolio
income. Any money you ever make (other than maybe winning the lottery or receiving an inheritance) will fall
into one of these income categories. In order to understand how to become rich and create wealth it's vital
that you know how to generate multiple streams of passive income.

Crossing the Chasm

Passive income is income generated from a trade or business, which does not require the earner to
participate. It is often investment income (i.e. income that is not obtained through working) but not
exclusively. The central tenet of this type of income is that it can expect to continue whether you continue
working or not. As you near retirement you are most definitely seeking to replace earned income with passive,
unearned income. The secret to wealth creation earlier on in life is passive income; positive cash-flow
generated by assets that you control or own.

One of the reasons people find it difficult to make the leap from earned income to more passive sources of
income is that the entire education system is actually pretty much designed to teach us to do a job and hence
rely largely on earned income. This works for governments as this kind of income generates large volumes of tax
but will not work for you if you're focus is on how to become rich and wealth building. However, to become rich
and create wealth you will be required to cross the chasm from relying on earned income only.

Real Estate & Business - Sources of Passive Income

The passive type of income is not dependent on your time. It is dependent on the asset and the management of
that asset. Passive income requires leveraging of other peoples time and money. For example, you could purchase
a rental property for $100,000 using a 30% down-payment and borrow 70% from the bank. Assuming this property
generates a 6% Net Yield (Gross Yield minus all Operational Costs such as insurance, maintenance, property
taxes, management fees etc) you would generate a net rental yield of $6,000/annum or $500/month. Now, subtract
the cost of the mortgage repayments of say $300/month from this and we arrive at a net rental income of $200
from this. This is $200 passive income you didn't have to trade your time for.

Business can be a source of passive income. Many entrepreneurs start out in business with the idea of
starting a business so as to sell their stake for some millions in say 5 years time. This dream will only
become a reality if you, the entrepreneur, can make yourself replaceable so that the business's future income
generation is not dependent on you. If you can do this than in a way you have created a source of passive
income. For a business, to become a true source of passive income it requires the right kind of systems and the
right kind of people (other than you) operating those systems.

Finally, since passive income generating assets are usually actively controlled by you the owner (e.g. a
rental property or a business), you have a say in the day-to-day operations of the asset which can positively
impact the level of income generated.

Passive Income - A Misnomer?

In some way, passive income is a misnomer as there is nothing truly passive about being responsible for a
group of assets generating income. Whether it's a property portfolio or a business you own and control, it is
rarely if ever truly passive. It will require you to be involved at some level in the management of the asset.
However, it's passive in the sense that it does not require your day-to-day direct involvement (or at least it
shouldn't anyway!)

To become wealthy, consider building leveraged/passive income by growing the size and level of your network
instead of simply growing your skills/expertise. So-called smart folks may spend their time collecting diplomas
and certificates but wealthy folk spend their time collecting business cards and building relationships!

Residual Income = A Form of Passive Income

Residual Incomeis a form of passive income. The terms Passive Income and Residual Income are
often used interchangeably; however, there is a subtle yet important difference between the two. It is income
that is generated from time to time from work done once i.e. recurring payments that you receive long after the
initial product/sale is made. Residual income is usually in specific amounts and paid at regular intervals.
Some example of residual income include:-

Use of Other People's Resources and Other People's Money are key ingredient required to generate passive
income. Other People's Money buys you time (a key limiting factor of earned income in wealth creation). In a
sense, use of other people's resources gives you back your time. When it comes to raising capital, businesses
that generate passive income usually attracts the largest amount of Other People's Money. This is because it is
generally possible to closely approximate the return (or at least the risk) you can expect from passive
investments and so banks etc., will often fund passive investment opportunities. A good business plan backed by
strong management will usually attract angel investors or venture capital money. And real estate can often be
acquired with a small down payment (20% or less in some cases) with the majority of the money borrowed from a
bank typically.

Tax Benefits of Passive Income

Passive income investments often allow for the most favorable tax treatment if structured correctly. For
example, corporations can use their profits to invest in other passive investments (real estate, for example),
and avail of tax deductions in the process. And real estate can be "traded" for larger real estate, with taxes
deferred indefinitely. The tax paid on passive income will vary based on the individual's personal tax bracket
and corporate structures utilized. However, for the purposes of illustration we could say that an average of
20% effective tax on passive investments would be a reasonable assumption.

In summary:

For good reason, passive income is often considered to be the holy grail of investing, and the key to
long-term wealth creation and wealth protection. The major benefit of passive income is that it is recurring
income, typically generated month after month without a great deal of effort by you. Building wealth and
becoming rich shouldn't be about extracting every last bit of your own energy, your own resources and your own
money as there is always a limit to the extent you can do this. Tapping into the effective generation and use
of passive income is a critical step on the road to wealth creation. Begin this part of you wealth creation
journey as early as is humanly possible i.e. now!